Top dogs with great management and more – David shares the six key traits that define Rule Breaker companies.
Rule Breaker Investing
What Makes Starbucks, Ambarella, and Netflix Different
It's the Rule Breaker Investing Podcast with Motley Fool Co-Founder, David Gardner. Welcome back to the Rule Breaker Investing Podcast. I'm David Gardner. Your host, our companion site is rbi.fool.com. I like that, by the way, because it makes me think it runs batted in, which is a real positive in baseball. One of my favorite subjects, but that's for another podcast. Last podcast, we talked about what it is to be a Rule Breaker as a person. This podcast, we're going to talk about what it means to find a Rule Breaker, the company. After all, Rule Breaker Investing isn't about you and me. It's more about the companies that we're buying, and I like to find Rule Breakers. There are six attributes that traditionally I've described that start to hint that maybe this company is a Rule Breaker. Now, not every company has all six of these, but the more that I see, the more of these six attributes I find when I look at a company, the more I think it's a Rule Breaker with real great potential. It's also a higher risk approach to investing, as you'll find out, certainly, but let's go over the six Rule Breaker traits. By the way, I wrote these into a book called Rule Breakers, Rule Makers in 1998-09, and that book is still purchasable on Amazon. I still believe just about everything I said in the first half of that book, the first half was Rule Breakers, and I wrote that portion. My brother wrote the Rule Makers portion that closed the book, but so the signs are pretty much the same, but we have new and fresh examples. All right, let's get to it. Number one, I like to find companies that are top dog and first mover in an important emerging industry. Top dog and first mover in an important emerging industry. There are some really loaded phrases there. Top dog, that means we're looking for the leader. One of my favorite lines, if you're not the lead husky, the view never changes, and it's true in life. It's also true in business. I love to find the lead husky, the dogs that are taking all the rest of us to new unforeseen places. Of course, not dogs because these are great stocks and great companies, but I love to find the lead husky in an important emerging industry, so it's one thing to find a company that's doing really innovative things in leading. If it's an internet space, that's really powerful. If it's more about, I don't know, Tamagotchi.org, I'm probably not as excited about that possibly. You have to look and ask yourself, is this an important emerging industry, and the word emerging matters too. Rule breakers are often companies that are creating the world around us. That's attribute number one. Let me give a quick example. I'll give an example of each of these attributes, and for me, Tesla is a great example of a top dog and first mover in an important emerging industry. They weren't really the first two electric cars, so there's a little bit of fudging of the text here, but when you talk about a company that is leading the electric car revolution, Tesla's a great example of that. Number two. Number two is companies that have a sustainable advantage gain through business momentum, patent protection, visionary leadership, or inept competitors. The key phrase there is, of course, sustainable advantage. We're not looking for flash in the pan companies, fly by nighters, we're not looking for stocks that look temporarily underpriced. We're looking at companies that have a real sustainable advantage. I do give, for example, business momentum, patent protection, visionary leadership, or inept competition, sometimes more than one of those is in place, but let me give a quick example of company, and for me, Starbucks is a great company. When you think about sustainable advantage, I would say of those four attributes, visionary leadership, Howard Schultz, who's really founded and guided Starbucks for a few decades now is an outstanding example of visionary leader. The sustainable advantage Starbucks enjoys is that brand name, is that ubiquity. We're buying their coffee beans for our kurig, clicking amazon.com these days, and that's not even going into Starbucks, but the ubiquity of all their stores made their brand an expected thing and everything from airports to usually slightly more upscale neighborhoods, and it's really gone global. There's a tremendous sustainable advantage that Starbucks has been building and benefiting from for decades. Number three, here's a funny one because a lot of people would think the opposite. Number three is strong past price appreciation. Most people think the secret to investing is buy low and sell high, and so they're looking for cheap, sometimes beaten down, sometimes broken companies thinking that the real way to profit is to buy something really low, but really for us, especially when you think about these companies, we're looking for the winners. We think the winners generally keep on winning, so it's as simple as looking at the stock and saying, "Is this company beating the stock market averages over the last six months or 12 months or whatever timeframe you want to look at?" For me, that's actually a real positive, and I realize that flies in the face of a lot of investors and investment philosophies, but this is the Rule Breaker Investing Podcast you're listening to. These are the rules that we operate off of, and a good example for me is Amberella, which is the video chip maker in GoPro cameras, increasingly security cameras, lots of high death cameras today, and Amberella has just been in an outstanding stock and just keeps hitting new heights, and a lot of people who kept avoiding it when it was already at a 52-week-high a year ago have missed another four times their money that they are sitting on the sidelines watching what they could have made because they were resisting strong past price appreciation, so we like that. Attribute number four, good management and smart backing. After all, it is not, at the end of the day, the industry or the products and services that are going to cause your Rule Breaker to be really a brilliantly managed company in stock. It's going to be the people that are making the decisions about the products and services, and so good management and smart backing, and there are many examples, but I'll just give Netflix as a quick example of the smartest guys in the room in their industry as the internet became the platform for video entertainment. Netflix was way out ahead of it. Before they were, obviously, they were just delivering DVDs to our door through mail, but they started to shoot their own business model in the foot when they began to do online streaming, and it was way out ahead of everybody. That's good management. Number five, strong consumer appeal, so I like this, and I think it's really important. It's not true of every business, and certainly there are many very successful large companies that don't really have a big, well-known brand name. I can think of, let's go with Canadian Railroad, one of our Canadian National, which is one of our stocks in Motley Fool's Stock Advisor, not a phrase that comes trippingly off the tongue or a business that everybody feels like they understand, but it's been a great company. There are many examples. Berkshire Hathaway, if you're an investor, you probably know that company. You may not know that company, but I like to focus on companies that we all do know, because I feel like that says a number of important things about how sustainable that is, how hard it was to even make their brand clear and make us aware of it in the first place. It says some great things about the future of that company. We usually go back and keep buying from the same brands over and over, so strong consumer appeal is important. And for me, how about Apple? Apple's a great example of this, there are many others in my investment approach. My final one, as we close out this edition of Rule Breaker Investing, is number six, documented proof that the stock is considered overvalued according to the financial media. So kind of like number three, strong past price appreciation, this goes against what most people think of, because if all of a sudden your company is on the cover of Barron's, the popular financial weekly that's been published for decades as a bad stock. If you're the cover child for being overpriced, you would think that's a bad thing, but in my experience, it's often quite the opposite. And here's why, to close, because if you can find a top dog and first mover in an important emerging industry that has a sustainable advantage, strong past price appreciation, good management and backing, and strong consumer appeal, and somebody in the financial media is telling you that it's a bomb company, or it's overvalued, I submit it's probably exactly the opposite. And that's why this attribute is important to look at as Rule Breakers. And I'll give you a quick example to close, how about Amazon.com, which was called Amazon.bomb on the cover of Barron's back in the year 2000, and Amazon's up a good amount ever since. So Amazon is regularly called overvalued. There's a misconception about whether they're making money or not. We've watched for 15 years now, people call Amazon.com overvalued, and the stock is up almost 150 times since we first picked it. So there's a good example. All right, those were the six attributes that make up Rule Breaker companies. Again, we don't find everyone in every company, but the more we can find in a company we're looking at or researching or thinking about buying stock in, the more we get interested in that company. And in future podcasts, if you like, I would be happy to take each of those attributes and spend five to seven minutes and just drill a little deeper. But for this one, I wanted to skate over the ice fast so we could get a sense of the whole rink. Thanks a lot for listening. I'm David Gardner, Fool on. As always, people on this program may have interest in the stocks they talk about, and the Miley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. Learn more about Rule Breaker investing at rbi.fool.com [music] [BLANK_AUDIO]